Best Mutual Funds for Short-Term Investing

How to Choose the Best Mutual Funds to Invest for the Short Term

Choosing the best mutual funds for short-term investing needs can be more challenging, and potentially more risky, than the investing choices you make for your long-term investing needs, such as retirement.

Most investors have more short-term savings goals and financial needs than they do long-term investing goals. Some of the general reasons that people want to take advantage of short-term investments include earning better interest than traditional banking accounts or trying to achieve returns that can keep up with inflation. You may have other short-term goals, such as an emergency fund, vacations, or a down payment for purchasing a new vehicle.

What Exactly Is Short-Term Investing?

When you read or hear about short-term investing, the terminology is generally referring to investing for periods of less than three years. It is important to keep in mind that many investment securities, including stocks, mutual funds, and some bonds and bond mutual funds, don't really make sense for investment periods of less than 3 years. For this reason it is important to know and understand which investments work well for short-term periods and which one do not.

Generally, stocks and stock mutual funds are not appropriate for short-term investing, This is because the odds of losing value in that time frame are too great for investors to risk, in exchange for higher returns. Most bond funds are appropriate for short-term investing. However, if there is any foreseeable risk of rising interest rates, investors may want to avoid long-term bond funds because of their interest rate sensitivity.

Mutual Funds Suitable for Short-Term Investing

Some investors and savers may prefer money-market mutual funds (different than money-market accounts) for their liquidity and relative safety but bond funds will generally provide the best yields and returns for short-term periods of one year to three years.

Here are some of the bond fund types you might want to consider for your short-term financial goals:

Ultra-Short-Term Bond Funds can be a smart choice for investors wanting yields higher than money market funds but less interest rate risk than bond funds with longer durations. In some environments, such as periods of rising interest rates, it is possible that ultra-short-term bond funds will not outperform money market funds. As an investor, you will need to choose carefully between the two. Generally, ultra-short-term bond funds can produce average annualized returns of 2 percent to 3 percent, especially over periods of more two or more years.

Short-term Bond funds primarily invest in bonds that have maturities of less than 4 years. Conservative investors tend to like short-term bond funds because they have lower interest rate sensitivity. However, short-term bond funds have lower relative average returns over time than intermediate and long-term bond funds. A reasonable average rate of return to expect over a three-year period is around 3 percent to 4 percent for short-term bond funds. This rate of return is sufficient to match the rate of inflation.

Intermediate-term Bond funds primarily invest in bonds that have maturities averaging between four and 10 years, although these bond funds are still appropriate for periods less than three years These bond funds offer a combination of reasonable returns, averaging around 5 percent. However, keep in mind that the interest rate risk is higher for intermediate-term bond funds than those with shorter durations. Therefore, if interest rates are expected to rise in the near future (and during the projected investment time horizon), investors may want to avoid intermediate-term bond funds.

As a final word on short-term saving and investing, investors should remember that risk tolerance plays a role here, just as in investing for longer periods. For example, if an investor is not comfortable with a chance of losing principal over the investing/saving period, it may be more suitable for that investor to use safer, more liquid vehicles, such as money market funds, certificates of deposit, or bank savings accounts for their needs.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.